Case-study 6-1 : Transfer Pricing

Illustration - I

Solution : Lambda Company

For Product X• Standard cost = Material Purchased

Outside+ Direct labor +Variable overhead+ Fixed overhead per unit

• =2+1+1+3=7

10 percent return on inventories and fixed assets=0.1×[（ 30,000+70,000)/10,000]=1

Transfer price = 7+1 = 8

For Product YStandard cost= Material Purchased

Outside+ Direct labor +Variable overhead+ Fixed overhead per unit+ Transfer price of X

• =3+1+1+4+8=17

10 percent return on inventories and fixed assets=0.1×[（ 15,000+45,000)/10,000]=0.6

Transfer price=17+0.6=17.6

• For Product Z:

Standard cost= Material Purchased Outside+ Direct labour +Variable overhead+ Fixed overhead per unit+ Transfer price of Y

=1+2+2+1+17.6=23.6

Illustration - II

Problem 2 - Lambda Company (with additional information)

For Product X• Standard variable cost =Material

Purchased Outside+ Direct labor +Variable overhead =2+1+1=4

Monthly charge=fixed costs+10 percent return on inventories and fixed assets

=3+0.1×[（ 30,000+70,000） /10,000]=4

Transfer price= 4+4=8

For Product Y• Standard variable cost =Mat Purchased

Outside+ Dir lab+VOH+ Transfer price of X =3+1+1+8=13

Monthly charge=FC+ 10 percent return on inventories and FA =4+10%×[（ 15,000+45,000） /10,000]=4.6

Transfer price=13+4.6=17.6 Unit standard cost = Variable cost+ Fixed

cost = 13+4=17

• For Product Z:

Standard cost =Material Purchased Outside+ Direct labor +Variable overhead+ Fixed overhead per unit+ Transfer price of Y=1+2+2+1+17.6=23.6

Illustration : III

Solution Under possible competitive price $26.00

If company maintain the price at $28, the profit=(28-23.6) ×7,000=30,800

If company follow the possible competitive price at $26, the profit= (26-23.6) ×10,000=24,000

Under possible competitive price $27.00

• If company maintain the price at $28, the profit=(28-23.6) ×9,000=39,600

If company follow the possible competitive price at $27, the profit= (27-23.6) ×10,000=34,000

Solution Under possible competitive price $25.00

If company maintain the price at $28, the profit=(28-23.6) ×5,000=22,000

If company follow the possible competitive price at $25, the profit= (25-23.6) ×10,000=14,000

Under possible competitive price $23.00

If company maintain the price at $28, the profit=(28-23.6) ×2,000=8,800

If company follow the possible competitive price at $23, the profit= (23-23.6) ×10,000=-6,000

Solution • Under possible competitive price $22.00

If company maintain the price at $28, the profit =(28-23.6) ×0=0

If company follow the possible competitive price at $22, the profit

= (22-23.6) ×10,000=-16,000

Summary : Comparison between the options

If the company follows the competitive price, the opportunity losses are shown as followed:

1. The possible competitive price is $27.00, opportunity loss=39,600-34,000=5,600

2. 2. The possible competitive price is $26.00, opportunity loss=30,800-24,000=6,800

3. The possible competitive price is $25.00, opportunity loss=22,000-14,000=8,000

4. The possible competitive price is $23.00, opportunity loss=8,800-(-6,000)=14,800

5. The possible competitive price is $22.00, opportunity loss=0-(-16,000)=16,000

Further Questions and Answers

a) With transfer price calculated in problem 1, is division C better advised to maintain its price at $28 or to follow competition in each of the instances above?

Answer- So, no matter how much is the possible competitive price, when the company maintain its price at $28.00, it can get more profit than follow the possible competitive price.

b) With the transfer prices calculated in Problem 2, is Division C better advised to maintain its present price at $28.00 or to follow competition in each of the instances above?

Answer- Because the answer to the Problem 2 is the same as the answer to the Problem 1, so the answer to this question is the same as the question 3 (a).

Maintaining the price at $28.00, the company can get more profit.

c) Which decisions are to the best economic interests of the company, other things being equal?

Answer- From the question 3 (a) and 3 (b), no matter which method the company use to calculate the cost, when the company maintains the price at $28.00, the company can maximum the profit.

d) Using the transfer prices calculated in Problem 1, is the manager of Division C making a decision contrary loss to the company in each of the competitive pricing actions described above?

Answer- No. The goal to the company is maximum its profit, and as per calculation, when the company maintains its price at $28.00, it can get the most of profit, so the manager has acted in the best interest of the company.